S.F. City College bonds downgraded amid woes

Claudeen Narnac walks down the steps in front of a City College of San Francisco sign in San Francisco, Calif. on July 3, 2013

Claudeen Narnac walks down the steps in front of a City College of San Francisco sign in San Francisco, Calif. on July 3, 2013

Photo: Ian C. Bates, The Chronicle

Photo: Ian C. Bates, The Chronicle

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Claudeen Narnac walks down the steps in front of a City College of San Francisco sign in San Francisco, Calif. on July 3, 2013

Claudeen Narnac walks down the steps in front of a City College of San Francisco sign in San Francisco, Calif. on July 3, 2013

Photo: Ian C. Bates, The Chronicle

S.F. City College bonds downgraded amid woes

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Standard & Poor's last week downgraded San Francisco Community College District's general obligation bonds, citing "the district's persistent difficulty in resolving sanctions" imposed by the regional commission that accredits community colleges in California.

The single-college district learned on July 3 that the commission will revoke City College of San Francisco's accreditation on July 31, 2014. The college is attempting to get the commission to reverse its decision as it tries to fix the financial and governance problems that led to it.

If the decision stands, the college - which serves about 85,000 full- and part-time students - probably will be forced to close.

S&P said the potential loss of accreditation "is likely to reduce student demand in fiscal 2014, thereby setting the stage for a decline in operating revenue in fiscal 2015 under the state's enrollment-driven funding formula."

An "additional credit weakness" it cited is the district's promise of lifetime health benefits to eligible current and retired employees, "which we believe represents exposure to potentially significant long-term health care cost inflation."

S&P lowered its rating to single-A from single-A-plus and maintained its "negative outlook," a sign that another downgrade is possible.

Most community colleges "tend to be in the single-A or double-A category in California," S&P analyst Misty Newland said. Although City College is at the low end of that range, it does not have the lowest community college rating in the state, she added.

Tax pledge

The voter-approved bonds are backed by unlimited ad valorem property taxes levied on San Francisco property. Ad valorem means the rate is a fixed percentage of assessed value.

An unlimited tax pledge "requires the county to levy a tax sufficient to cover debt service payments through the bonds' maturity, regardless of changes in property values, school district finances, district management, student enrollment, or attendance," bond underwriter Stone & Young-berg said in a report on California school district financing.

Moody's rates the district's bonds A1 - a notch higher than S&P's current rating - but has them on review for a possible downgrade.

In a note last week, Moody's said it expects that payment of the bonds "will not be interrupted because the county, not the (district), levies and collects property taxes and acts as the paying agent for the district's bonds. However, the smooth functioning of this process has not been tested in the case of a complete closure of a (community college district), which is a possible scenario in San Francisco's case."

This tax should not be confused with a parcel tax city voters approved in November. The parcel tax - $79 per property for eight years - will bolster City College's operating revenue. It is not earmarked for bond repayment, but S&P cited it as a positive in its rating decision. "It provides the college with more resources to make changes" that could help it retain accreditation, S&P analyst Chris Morgan said.

It's not clear whether the city could continue to collect the parcel tax if the college shut down. That's "an open question," a now-departed college spokesman told me last month.

Price action

Fitch Ratings, the third major credit rating agency, downgraded City College in late March to triple-B-plus from single-A-minus. Its current rating is two notches below S&P's and three below Moody's

The district had about $372 million in general obligation bonds outstanding as of June 30, 2012. The bonds trade infrequently and when they do, prices vary widely, making it hard to judge the impact of the accreditation woes.

Take, for example, the district's general obligation bonds issued in 2006 and maturing in June 2028 (15 years from now). The last reported purchase of this bond was on Tuesday, at a price that translates into a 3.02 percent yield. That's below the 3.5 percent yield on a generic triple-A-rated general obligation bond, says Matt Fabian of Municipal Market Data.

Normally investors demand higher yields on lower-rated bonds. If investors were worried about City College bonds, they theoretically would want more than 3.5 percent.

There is "no rhyme or reason" to these "little retail trades," Fabian says. However, "if the college were to sell new bonds, they would probably pay more" than 3.5 percent.

Detroit's bonds

Many investors like general obligation bonds because their interest is tax-free and they are backed by the issuer's taxing authority. Defaults have been exceedingly rare.

That faith has been rattled recently. The emergency manager of Detroit, which became the largest U.S. city to file for bankruptcy last week, said before the filing he wanted to impose significant losses on some of the city's general obligation bonds.

On Friday, Fitch said it remains "concerned that the chances for full and timely payment of (Detroit's) unlimited tax general obligation appear weak despite the city's adherence thus far to its pledge to levy and collect a voter-approved tax specifically for that purpose."

The Detroit bankruptcy filing was thrown into confusion Friday when a judge ruled that it violated the Michigan Constitution and state law and must be withdrawn. Michigan's attorney general said he would appeal that decision.

Bill Brandt, chief executive of Development Specialists Inc., a debt restructuring firm, said it would be a "watershed event" if a large city such as Detroit "did not pay 100 percent of its general obligation debt. If the state of Michigan let that happen," other Michigan cities could have a hard time borrowing money.

Likewise, he could not see San Francisco supervisors letting City College default on its debt. "They would not want to have other bonds affected," he said. According to S&P, the supervisors have the power and obligation to levy taxes at the district's request for the bond repayments.

Unlike Detroit, San Francisco has a robust property tax base, and the college itself has valuable property that could be sold to satisfy creditors.

If the college were to shut down, "I suspect there would be a few hiccups," Brandt said, but in the end, "I would expect that the supervisors would make sure the bonds get paid."